Option Trading Tip #2
My top 10 call and put option trading tips that I have learned, and that you MUST know before you start trading calls and puts.
Trading Options Tip #2:
Never buy a call option or a put option without first looking at the chart of the underlying stock or index. Study the chart of the stock at the 1 month, 3 month and year long time periods and look for trends, support, resistance, and channels.
Before you buy a call or a put option on a stock, it is an absolute MUST that you take a look at a chart of the stock. Look at the 30 day chart, then the 90 day, then the year long chart. Do you see any trends or patterns?
When looking at the chart look for the underlying trend, is the stock price in a long slow uphill climb? Is the stock in a long slow decline? Or is the stock in a narrow trading range with no indication of making a move? Is the chart pattern consistent with your initial strategy? To find the trend, look for the overall direction of the stock price and try to draw a straight line in the middle of the stock prices you see. Once you have drawn this line, then draw the a line on top and a line on the bottom to indicate the channel that it is trading in.
If you are thinking about buying a call, ask yourself why you think the stock price will go up. If the stock hasn't been trading at that level recently, then it won't be easy for it to get there now either unless their is a new event or new information. Is an earnings announcement coming? Is there a shareholder meeting? Is there a new product or version release coming soon?
Support Levels and Buying Call Options
If I see a stock chart that indicates there is solid support at a certain (lower) price and the stock price has come down to that level, it might be a sign to buy a call as the call options will be cheaper and there is a good change the stock price will bounce up off of that support level. Now never be greedy! If you are looking for a bounce off the support level and you get it, take your profits!
Resistance Levels and Buying Put Options
Likewise, if I see a stock chart that indicates there is a strong resistance level at a certain (higher) price and the stock price is approaching that level, it might be a sign to buy a put as the put options will be cheaper and there is a good change the stock price will come under selling pressure as it nears the resistance level and fall off of that resistance level. Again never be greedy! If you see the stock price fall then take your profits!
Stock Chart Channels and Buying Call and Put Options
If the stock is currently at the lower level of its trading range, then in its normal daily price changes it might move back to the center of its range. In this case you can often take a small profit just as the price moves back into the upper half of its channel. I call this taking a few nickels from the option price movement. Buying a call at $1.00 and selling it an hour or a day later at $1.15 is a nice 15% profit.
After studying a stock chart, identifying a support/resistance/channel, and establishing an expectation about the future direction of the stock price, the next thing to do is to study the stock's option chain and look at the prices of the options.
Here are the top 10 option concepts you should understand before making your first real trade: